Heightened Expectations Before Earnings Season Starts 07-09-2010

Cusick’s Corner
The trading week has come to an end and the bulls have taken this market somewhat by the horns. I say somewhat because this recent rally (close to 5% in the S&P September E-minis) has not broken through the down trend from the May highs on any index. We need to also remember that next week kicks off earnings season. There are some heightened expectations that could give this market the jump start needed to potentially challenge the 2 month down trend. We also have option expiration next week, which could add some fireworks as well. Make sure that you shore up a plan before the start of next week if you have expiring options and take advantage of screening the market for best of breed stocks in front of these events for potential opportunities. See you Monday and have a great weekend.

Stocks finished the week on a positive note, but Friday was a slow news day with not much to guide the action one way or the other. After a three-day 450-point rally, the Dow Jones Industrial Average opened modestly higher heading into a report on Wholesale Inventories at 10:00 ET. The data showed an increase of .5 percent in May and not much different than the .4 percent increase that economists had predicted. The market showed little reaction to the news and the major averages were flat at midday. From there, modest buying interest surfaced and the Dow Jones Industrial Average had moved into positive territory by mid-afternoon. At the closing bell, the Dow was up 59 points and not far from session highs. The NASDAQ added 21.

Bullish Flow
Forest Labs (FRX) added 7 cents to $28.39 and bullish trading surfaced in the pharmaceutical company late Friday. In this trade, the investor was buying August 32.5 calls at 15 cents and selling August 25 puts at 20 cents. This “risk-reversal” fetches a credit of 5 cents and traded 5000X. It’s a bullish play because it makes its best profits if shares make a substantial move higher. However, if the stock falls to $25, this strategist is apparently a willing buyer because they are selling uncovered puts with a $25 strike. The same spread saw interest on Thursday and the activity is noteworthy because it comes ahead of the company’s July 20 earnings release.

Bullish order flow was also seen in Altera (ALTR), Ford Motor (F), and Wendy’s (WEN).

Bearish Flow
Tyson (TSN), the Springdale, AZ food company, added 34 cents to $17.54 Friday and options volume hit 8X the typical levels. About 10,000 puts and 1,600 calls traded on the session. The top trade was a block of 3,900 October 15 puts at 50 cents on the ISE, where ISEE sentiment data indicate an opening customer buyer. Beyond that, much of the action was in smaller lots trading at 50 cents. At the end of the day, 9,700 contracts had traded and implied volatility edged up 2.5 percent to 43. It appears that premium buyers were initiating the trades and possibly hedging positions in TSN or making outright bearish bets that shares will fall below $15 by mid-October.

Bearish flow also picked up in Cypress Semi (CY), Microstrategy (MSTR), and WMS Industries (WMS).

Index Trading
The CBOE Volatility Index (.VIX) lost .73 to 24.98 and has now suffered a six-day 27.7 percent losing streak. VIX is under pressure as the equity market has been rallying and investors look ahead to the “summer doldrums,” which is sometimes an uneventful and quiet period on Wall Street. Yet, while VIX has been falling, actual levels of market volatility remain relatively high. The 20-day statistical volatility of the S&P 500, for example, is 24 percent. In fact, some players in the options market were apparently taking positions in anticipation of a rally in the volatility index Friday and buying VIX July 27.5 – 35 call spreads at 95 cents. Both contracts traded more than 20,000X. These spreads are short-term plays because VIX July options expire in 11 days.

ETF Trading
Select Sector Financials (XLF) added 20 cents to $14.51 and notable trading activity was seen in the July 15 calls. More than 150,000 contracts traded. The action included a buyer of 115,000 contracts at 8 cents each, according to a source on the exchange floor. This buyer is making a bold bet because July options expire a week from today. The massive premium purchase might be in anticipation of strong earnings from several large US banks, which are due to report results on July 15 and July 16.